February 2009

We often circulate what we call “QuickBlasts,” which discuss, very briefly, what we think are interesting or important developments. Below is the text of one such QuickBlast–on a major case from the Delaware Supreme Court:

Fiduciary Duties Expanded & Director Independence Examined

TheGantler v. Stephensdecision by the Delaware Supreme Court on January 27, 2009 changes the game, so to speak, for directors and officers liability, among other things. While the decision relates to board action involving an abandoned merger, the decision will affect many significant actions by directors and by officers. Taken with other recent Delaware decisions (e.g., Lyondell), it should be clear that the Delaware courts are tightening the screws on those who run companies. In a sense, the court once again reminds the corporate world that reality matters.

In a Nutshell.

Very briefly: The Delaware Supreme Court reversed a lower court’s ruling and denied a motion to dismiss a challenge by a shareholder (who was also a former director). The board had engaged an investment bank that had found some potential acquirers. At some point during due diligence the board abruptly abandoned discussions with the potential acquirers. Several weeks later the board chose to reclassify the shares (essentially taking the company private).

So What?

And almost as briefly, here are some of the reasons the opinion matters:

1. Independence Is Based on the Facts.The decision makes clear that the Delaware courts will closely examine the facts and not only the form of the actions by the directors. In this case, that close scrutiny arose with the court’s examination of the basis for certain directors to claim independence. (They found that independence was not supported by the facts.) The good news is that a decision on a transaction can be defended if board independence withstands scrutiny.

2. The Business Judgment Rule Applies.The standard for review is the “Business Judgment Rule,” rather than the more stringent Unocal standard. Unocal applies only when a board engages in “defensive” actions and this one was not a defensive action. As the court said, under the Business Judgment Rule “[. . .] the board is entitled to a strong presumption in its favor, because implicit in the board’s statutory authority to propose a merger, is also the power to decline to do so.” This lower standard will apply only if the assertions of disinterest and independence of the board members can be supported by the facts.

3. Officers Are on the Hook, too.Put simply, officers of Delaware corporations have the same fiduciary duties as do directors. This is quite significant.

4. “Careful Deliberation” Means Just That.The proxy statement issued for the transaction stated that the board had carefully deliberated on the possible merger but the court looked closely (again, those pesky facts) and found that this was simply not so. Saying it was so just made it worse. This meant that the defense of shareholder ratification collapsed because the shareholders who approved it were not adequately informed.

The Juicy Bits.

This is not the place to analyze the opinion in detail (after all, these are called “QuickBlasts” for a reason). So, we’ll make a few more comments and keep monitoring events as they unfold. Here’s what we think is interesting. The court determined that the Company’s inside director was not independent because he knew that at least one potential acquirer intended to replace the board members. In addition, the court also found that two directors were not truly independent because their local businesses provided a substantial amount of services to the company. Hence, our point about facts and the reality of “independence.”

As for the fiduciary duties of officers, Gantler is the first time that the Delaware Supreme Court has made a clear statement of this rule. To some this comes as no surprise. But, what’s troubling is that officers do not have the protection under Delaware statute granted to directors. This could get a bit dicey. Nonetheless, officers now need to understand such principles as conflicts of interest and the duty of loyalty. Some of us would say, well, it’s about time.

Closing Comments.

One could say that Gantler represents the Delaware courts again reminding the corporate world about reality, especially in corporate governance—i.e., independence—but also, this time, the fiduciary duties of the officers. In other words, the courts there understand that officers wield a lot of influence while also, potentially, being subject to all sorts of “temptations” that directors cannot consider. Now, essentially, everyone who runs a company—officers and directors alike—are judged by the same standards. Not bad for a day’s work of the Delaware Supreme Court.